BlackRock Commentary: Recession eclipses U.S. midterm result

Wei Li, Global Chief Investment Strategist of the BlackRock Investment Institute, together with Alex Brazier, Deputy Head Vivek Paul, Head of Portfolio Research and Kurt Reiman, Senior Strategist for North America all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points

Recession Looms: The recession we see from Federal Reserve rate hikes eclipses any impact from U.S. midterm elections. We stay underweight developed market (DM) stocks.

Market backdrop: Yields rose and stocks rallied off lows as markets mulled the scope of central bank rate hikes amid a “whatever it takes” campaign to curb high inflation.

Week ahead: Markets are pricing another 0.75% rate hike by the European Central Bank this week. U.S. PCE inflation will be in focus before the Fed’s meeting next week.

Equities usually do well after U.S. midterms. Why? Gridlock is common and prevents policy change that could spook stocks. We don’t see that past playbook working this time due to the recession we expect from the Fed ratcheting up rates. Gridlock dims any prospect of fiscal stimulus that only works at cross-purposes with monetary policy in the new regime – take the UK. We stay underweight DM stocks but see the politics of higher rates taking over from the politics of inflation.

Housing Stops

U.S. housing starts during policy rate tightening cycles, 1972-2022

We see a bigger problem for stocks than any potential positives from the midterm election outcome: a looming recession. We have argued how central banks rushing to hike policy rates to get inflation back to target would need to crush interest rate-sensitive parts of the economy first. That’s because higher inflation is driven by production constraints. Recession will pressure other sectors in time, but we’ re already seeing damage in important rate-sensitive sectors like housing. As mortgage rates soar along with the Fed’s aggressive rate hikes, the number of new housing starts is falling quickly. The slide in housing starts this year (see orange line in the chart above) is already steeper than past mega Fed rate-hike cycles such as in the 1970s and early 1980s – as well as the unwind of the mid-2000s U.S. housing boom (other colored lines).

We’ve said the playbook from the Great Moderation, a four-decade period of steady growth and inflation, won’t work in this new regime of heightened macro volatility. Recession outweighs factors in previous U.S. midterm elections that were seen as positive for stocks, such as resulting policy gridlock. Gridlock typically meant lower odds of change that could affect stocks. Equities also have yet to fully reflect recession and earnings risk, we think. We’re not chasing bear market rebounds.

Midterms hold no sway

The midterms won’t sway our view. Recession matters more and any resulting fiscal stimulus can only work at cross purposes when inflation and debt levels are high, and rates are rising. We’ve seen how it can threaten a fragile equilibrium and revive bond vigilantes. Case in point: the UK. The episode of historic long-term gilt volatility shows what can happen when governments try to respond to high inflation with unfunded fiscal spending. We’ve moved to neutral on UK gilts from underweight as perceptions of fiscal credibility have improved after the U-turn on the fiscal mini-budget. We think the Bank of England will have to hike rates less than we assumed immediately after the plan. Still, political turmoil and the resignation of Prime Minister Liz Truss, warrant caution. Fiscal policy can’t save the day, we think – it’s a recession foretold. Production constraints mean the only way to get inflation down to target would be to curb the level of activity to what the economy can comfortably produce now. We don’t think fiscal stimulus would result in stronger growth but just higher interest rates and debt servicing costs.

We see political focus increasingly shifting to the economy. We expect inflation to come down, but stay above target – and recession will still hit.  We then think the politics of inflation could switch to the politics of higher interest rates. We see the politics of rates creeping into the politicization of everything with more voices beginning to decry the aggressive rise in interest rates that is causing recession. We see the Fed stopping its hikes amid the economic damage and pressure to ease up on tightening, but price pressures will persist. That’s why we think it will eventually have to live with some inflation.

Our bottom line 

We’re underweight DM equities. We see rising rates causing recession as inflation persists. The Fed is responding to the politics of inflation, or the pressure to tame it, we think. We see the Fed pausing but only after the economic damage of rate rises is clear. All this outweighs any expected boost for stocks after the midterms, in our view. We also think any resulting fiscal stimulus would only work against monetary policy in this new regime. We eventually see the politics of rates overtaking the politics of inflation as political focus sharpens on the economy into the 2024 elections.

Market backdrop

U.S. and German bond yields hit new multi-year highs as markets brace for more central bank rate hikes. That has kept equities pinned near two-year lows despite occasional bear market rallies. Major central banks are expected to deliver big rate rises at upcoming meetings as they pursue a “whatever it takes” approach to curb inflation, starting with the European Central Bank next week. We expect them to carry on until the economic damage caused becomes clear.

We expect the European Central Bank to stick to an aggressive tightening path and raise rates on Thursday. The Fed’s preferred metric for inflation – the PCE for – comes out on Friday, a week before markets see it lifting policy rates 0.75% to 3.75-4.0%. Manufacturing September data around the world could also give early signs of the recessions we expect.

Week Ahead

Oct. 24: Global flash PMIs

Oct. 25: U.S. consumer confidence

Oct. 27: European Central Bank policy decision; U.S. GDP

Oct. 28: U.S. PCE; Bank of Japan policy decision


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 25th October, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. As part of Templeton Global Equity Group, the European equity desk is manned by a team of professionals based in Edinburgh, Scotland, whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Global equities finished broadly higher last week, with the MSCI World Index up 3.6%, the S&P 500 Index up 4.7%, the STOXX Europe 600 Index up 1.3%, whilst the MSCI Asia Pacific Index closed down 1.5%. The bounce last week was mainly attributed to technical factors, as we some of the most-shorted stocks outperformed. In the latest Bank of America Fund Manager Survey, bearish market sentiment was highlighted. Cash levels hit their highest level since 2001, and with 49% of investors underweight equities, this seemed to set up a strong reversal of recent losses. Also, comments on Friday in the Wall Street Journal regarding possible Federal Reserve intentions at upcoming meetings were taken as dovish, helping the market close out the week strongly. A 20% fall in gas prices—now down 66% from their peak—aided equities in Europe. But a number of headwinds persist.

There is turmoil in UK politics, with the “new” Prime Minister, Liz Truss, announcing her resignation following a dreadful 44 days in office. Also, earnings have disappointed overall so far, and stocks that did report last week fared poorly. In Asia, there were reports that China’s President Xi Jinping plans to push on with the country’s “Zero-COVID” policy. Finally, the moves higher last week were on lighter market volumes, with commentators using that to question the strength of conviction.

Change once again at Downing Street

Thursday brought Liz Truss’ resignation after just 44 days as UK prime minister. Calamitous decision-making by the “new” government caused turmoil in UK markets over the last few weeks, forcing the replacement Chancellor, Jeremy Hunt, to withdraw almost all of the pledges of his predecessor, Kwasi Kwarteng. The reversal of these plans was positive for markets, but terminal for Truss. Hunt’s announcement made Truss’ position untenable, and her resignation on Thursday made her the shortest-serving prime minister in UK political history.

Sterling rallied against the US dollar for a short while before paring all of its gains. Gilt yields rallied into the end of the week following reports that former Prime Minister Boris Johnson, in a bizarre twist, was among the favourites to stage a comeback for the role, stirring up market jitters.

Any contenders in the leadership contest needed the backing of 100 Conservative members of parliament (MPs) just to get into the ballot.

In the end, Rishi Sunak was declared prime minister. Sunak is the more market-friendly option, and the fiscal pivot Chancellor Jeremy Hunt delivered last week is likely to be cemented, with more fiscal tightening likely. Sterling rallied versus the US dollar on the news, whilst bond yields pulled back, with the UK two-year yield below 3.5%. There has been a lot of stress in UK credit markets since Truss took power, so Sunak’s confirmation should be a welcome relief. UK domestically exposed stocks also rallied.

Attention should likely shift to the government’s fiscal plan, which is due for announcement on 31 October. Chancellor Jeremy Hunt faces a tough challenge to balance the books, and reports suggest he is considering up to £20 billion of tax rises in the upcoming budget. It is thought that Hunt and Sunak are much more aligned on fiscal matters, so we don’t expect too many market shocks like we had in the aftermath of Kwasi Kwarteng’s mini-budget at the end of September.

The week in review

Europe

Last week was interesting for European equities, ending with a rally that pushed the market into positive territory. Technical factors seemed to drive the rally at the start of the week, with the year-to-date underperformers and the most-shorted stocks leading the way. In terms of the macro picture, UK political turmoil was the key focus for markets.

Attention has also begun to shift towards the latest earnings season, with around 15% of the STOXX Europe 600 Index reported last week. Earnings will really pick up pace this week. In terms of fund flows, European-focused equity funds recorded their 36th consecutive weekly outflow.

Sector performance divergence was significant last week. The technology sector gained last week, tracking the bounce in the United States on short covering and following ASML’s earnings beat. Autos were also higher last week following the well-received Paris Auto show and a solid European car sales number for September.

Banks were also stronger on the week. Earnings in the space were off to a solid start despite a report in the United Kingdom that Jeremy Hunt was “preparing to raid the profits of banks” in his budget (if it happens). Meanwhile, the defensives lagged last week, including telecommunications, food and beverage and health care. Aero and defence stocks were up once again, amidst a focus on European defence spending. Also, European airlines managed to hold on to their recent gains after some supportive earnings reports.

Falling gas prices in the European Union (EU) helped market sentiment last week; reports show gas storage is at 92% of capacity, which is above average for this time of year. There were also further reports of the European Commission using purchasing powers in negotiations with global gas suppliers and on implementing a framework which would allow for a cap on the price of gas. Mild recent weather and ample supplies have helped drive further price declines as we kick off this week. Falling prices are a welcome boost for businesses around Europe.

United States

US markets recovered ground last week, bouncing from the year-to-date lows made in the prior week. Gains were broad based, with the  S&P 500 Index, the Dow Jones Industrial Average, Nasdaq and the small-cap Russell 2000 Index all closing higher last week.

Yet again, energy names led the market higher, with technology stocks also market leaders.  The defensives lagged in a more “risk-on” environment.

Of note, Friday was a strong session, with the S&P 500 Index up 2.4%, thanks to a Wall Street Journal article suggesting the Fed will discuss slowing the pace of rate hikes. San Francisco Fed Bank President Mary Daly also suggested discussion could turn to planning reductions in the pace of rate hikes. She stated: “It should at least be something we’re considering at this point, but the data hasn’t been cooperating.”

That said, earlier in the week US Treasury yields had widened as Minneapolis Fed Bank President Neel Kashkari struck a more hawkish line, stressing that there is no Fed pivot in sight. There will be no Fed speakers this week with the Fed in black out period ahead of its next meeting (2 November).

On this theme, last week’s BoA Fund Manager Survey showed a majority of respondents see the Fed ending its hiking cycle in the first quarter of 2023 (vs. the second quarter 2023 in the prior survey).

Looking at other gauges of investor sentiment, fund flow data was encouraging in the United States, with equities seeing inflows in the past two weeks. The CNN Fear & Greed Index has rebounded sharply to a “Neutral” reading, having only been in “Extreme Fear” territory just two weeks ago.  

Asia

Last week was another tough one for Asian markets, as the MSCI Asia Pacific Index closed lower, as well as regional markets in Hong Kong, China and Japan.

As Asian currencies weaken in the face of a rising US dollar, regional economies are at threat of importing inflation, forcing local interest rates higher.

The continuing fall in equity prices is prompting authorities in South Korea and Taiwan to contemplate a short selling ban on equities, support for the credit market and intervention in the domestic currency.

Japan’s equity benchmark declined last week on the back of global recessionary fears and further currency weakness. The yen had a torrid time, almost hitting 152 on Friday vs. the US dollar. Interestingly, the currency closed stronger on Friday after Japanese authorities were thought to have intervened for the second time in a month, although the ministry of finance did not confirm the action.

Elsewhere, investors refocused on the impact of higher US interest rates and a looming global recession after a two-day rally, while September core inflation ballooned to an eight-year high of 3%, exceeding the central bank’s 2% target for the sixth successive month.

The Bank of Japan (BoJ) meeting this week is likely to reiterate its support for easing policies despite the BoJ’s reduction of its balance sheet by more than any other central bank in the past few months.

Hong Kong’s market likewise declined last week, hitting a 13-year low on Thursday. Unsurprisingly, all eyes were on the Party Congress meetings last week.

The property sector traded lower after John Lee’s disappointing policy address, where he talked about refunding stamp duty for non-residents only after staying in Hong Kong for seven years. Semiconductor stocks dropped last week after reports the US may announce more curbs.

Developments in China, with Xi seemingly imposing absolute power, seem to have spooked markets in the first day of trading this week.

China’s equity market also closed the week lower, with the focus on the 20th Party Congress. President Xi removed his opponents from power and put his close allies into all the major seats of power. In addition to this, last Monday Beijing delayed releasing key economic data without explanation, which didn’t help the markets. The delay raised speculation that the third-quarter gross domestic product (GDP) report would show China’s economy was on track to miss the official growth target of c. 5.5% this year and that officials sought to avoid any fallout from its release during the weeklong Congress.

Sector-wise, tech shares weakened, pressured by reports that officials from the Ministry of Industry and Information Technology held emergency meetings with domestic chipmakers regarding the Biden administration’s recently announced restrictions on technology exports to China. Tourism, hotel, food and beverage, retailers and auto also dragged on the indices as the number of domestic tourists/tourism revenue during 2022 National Holiday both hit the lowest levels since the COVID outbreak in 2020. Property developer shares advanced on reports that the China Securities Regulatory Commission will allow certain companies with small property interests to raise money by selling domestic shares.

The week ahead

The key focus for this week will be the European Central Bank (ECB) meeting on Thursday, with a 75 basis point interest-rate hike expected. ECB President Christine Lagarde will also speak, likely to reiterate that quantitative tightening will begin after interest-rate normalisation has completed. The US GDP report on Thursday will also be closely watched. Earnings season gets into full swing this week, so focus will be on corporate reporting.

Monday, 24 October

  • France Purchasing Manager Indices (PMIs)
  • Eurozone PMIs
  • UK PMIs
  • US PMIs

Tuesday 25 October  

  • Spain Purchasing Managers Index (PPI)
  • Germany IFO survey
  • US Conf. Board Consumer Confidence/Expectations

Wednesday 26 October

  • Japan PPI
  • Australia Consumer Price Index (CPI)
  • France Consumer Confidence
  • US New Home Sales
  • Bank of Canada monetary policy meeting and interest-rate decision

Thursday 27 October

  • China Industrial Profits
  • Germany Consumer Confidence
  • Spain Unemployment Rate
  • Italy Consumer Confidence, Industrial Sales
  • European Central Bank rate decision
  • US GDP, Personal Consumption, Initial Jobless Claims

Friday 28 October

  • Japan Jobless Rate
  • Germany CPI France GDP, Consumer Spending, CPI
  • Spain GDP, CPI
  • Italy PPI
  • Eurozone Economic Confidence, Consumer Confidence
  • Canada GDP

 


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Past performance is not an indicator or guarantee of future performance. There is no assurance that any estimate, forecast or projection will be realised.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 24 October 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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